I never complain when an economist answers: “It depends”. Almost everything that luck throws our way comes with two aspects. Consider the introduction of the railways in Russia. In making the factories of Moscow accessible to inhabitants of Tver, Kaluga and Riazan, the railway condemned these provincial cities to decadence and turned Moscow into a metropolis. Good for consumers in the provinces, bad for the local manufacturers who were unable to survive the competition.
A rail journey – a symbol of modernity in the 19th Century that buried a bucolic past and heralded the future – begins and ends The Cherry Orchard, the play by Anton Chekhov. For him, who believed in the progress of science and technology, the railway was a symbol of goodness. For Tolstoy, on the other hand, it was a symbol of destruction, as shown in the most important moments of the tragedy that consumes Anna Karenina. The first meeting between Anna and Prince Vronsky takes place in a railway station and she takes her life by throwing herself under a train.
Whether it is the railway or oil, anything can be used for good or evil. In the same way, wealth not acquired as the result of work can turn into a curse. The heir that wastes the family’s legacy, instead of putting it to good use, usually ends up in a fix.
The same holds true for nations. It is easier for a government to extract riches from the earth, without planning for tomorrow, than to create the laws and institutions that will sustain the growth and stability of tax revenues. In Latin America, the colonial legacy of the exploration of natural resources resulted in poorly diversified economies subject to instability and crises.
Today, the main exports of Latin American countries are still based on natural resources. As the participation of commodities in export revenues is high, the fluctuations in the price of commodities and growth go hand in hand. The volatility of export revenue creates economic cycles that dictate government revenues. When public spending oscillates with revenue, the government is unable to react when the economy contracts.
What can be done to break this vicious circle? Where are the hidden aces? As regards the diversification of exports, how did Costa Rica and the Dominican Republic act? Or in the case of an anti-cyclical fiscal policy, what did Chile do?
In Costa Rica and the Dominican Republic, over 70% of export revenue currently from products manufactured in their free zones. Over the last four years, both countries have grown over 6% per year. But, in both cases, a weak fiscal budget, social tension and double digit inflation continue to threaten stability and sustainable growth.
In the case of Costa Rica, the opposition blocks the fiscal reform necessary to reduce public debt. In the Dominican Republic, the fiscal reform essential for the resolution of problems inherited from the 2000-2004 period (when a freely spending government wrecked a success story from the 1990s) continues uncompleted and impedes investment into education.
Chile offers the opposite strategy. Ninety percent of Chilean export revenue comes from agricultural products, copper and other metals. But the institutional reforms in favor of a free market economy, begun in the mid 1970s and maintained until now, have produced fabulous results. A comparison between the periods 1940-1985 and 1986-2007 show that, on average, private investment has increased by seven percentage points of the GDP, exports have doubled, inflation has fallen and productivity has accelerated.
Compared to the policies of other Latin American countries, the most extraordinary measure adopted by Chile was the anti-cyclical fiscal policy. In the periods during which copper prices are high, the government builds up its surplus. Therefore, it retains its ability to spend even when copper prices fall.
Between 2003 and 2007, taking advantage of the rising price of copper, Chile increased its fiscal surplus year on year. In 2007, this surplus stood at 8% of the GDP. With these resources, the government reduced the public sector debt, which had reached the equivalent of 50% of GDP in 1999, to less than 5% of GDP in 2007. The foundations of the Chilean house are now stronger should they need to withstand a storm coming from a possible reversal in commodity prices.
The case of Chile sustains the argument that an anti-cyclical policy is fundamental for the good use of natural resources and more important than export subsidies in guaranteeing sustainable growth.
Up until last year, Brazil had acted in the opposite manner to Chile. The increase in government income was always used to finance increased public spending. This trend seems to be present in 2008: just for the month of May, the government distributed fiscal benefits to automobile companies, created subsidies (so that automobile owners wouldn’t have to curb their gasoline consumption) and wrote off farmers’ debts (despite the high prices of agricultural products).
However, at the end of May the government announced a nominal surplus for the first quarter and the intention to promote an informal increase of the primary surplus. These promises were made prior to the Copom (which sets the Selic rates) meeting. Were these promises merely used to pressure the Central Bank into not raising interest rates? Or will they really come to pass?
Our exports are more dependent on commodities than those of other economies, such as Mexico, the Dominican Republic and Costa Rica. The government needs to curb its spending, further reduce its debt and strengthen institutions such as the Law of Fiscal Responsibility, in order to ensure its fiscal situation more closely resembles Chile’s. After all, will the promotion of Brazil to a country of investment grade be used for good, or for evil?